At its meeting today, the CNB Bank Board cut the two-week repo rate (2T repo rate) by 0.25 percentage point to 3.75 %. At the same time, it decided to cut the discount rate by the same amount to 2.75 % and the Lombard rate to 4.75 %. All seven Board members voted in favour of this decision. The new interest rates are effective from 7 February 2025.
The decision is based on a new macroeconomic forecast. It implies a slight decline in interest rates followed by their approximate stability from the middle of this year. The Board also had two alternative scenarios. The first one assumed faster growth in services and food prices than in the baseline scenario. The second alternative scenario assumes a further deterioration in external demand accompanied by more persistent domestic inflationary pressures, especially in services.
The CNB started cutting interest rates in December 2023 and gradually reduced them from 7 % to 4 %. It then paused the interest rate cut cycle in December 2024. Newly available indicators from the economy suggest that short-term upside risks to inflation are not materializing yet and external demand developments remain subdued. The Board therefore proceeded today to cut interest rates further cautiously. However, as the degree of monetary policy tightening is gradually easing and some longer-term upside risks to inflation persist, the Board will approach further potential monetary easing very cautiously. It is therefore possible that monetary policy will remain moderately restrictive for longer than expected in the baseline forecast scenario.
Core interest rates in real terms remain clearly positive, continuing to dampen private sector credit activity and hence money creation in the economy and, consequently, long-term inflation. However, this is counteracted by increased government deficit financing, whose contribution to money supply growth is above the long-term average.
At its next meetings, the Board will base its assessment of the newly available data and their implications for the inflation outlook on the new data. The rate-setting considerations will depend mainly on an assessment of the persistence of the low-inflation environment, the exchange rate of the koruna, the effect of fiscal policy on the economy, an analysis of labour market tensions and developments in domestic and external demand. The Board will also monitor the actions of key foreign central banks and geopolitical developments. The Board will also assess the transmission of interest rate cuts to lending activity, asset prices and subsequently to real economic activity and price developments.
The Board confirmed its commitment to continue monetary policy in order to keep inflation close to the 2% target in the long term. At present, this still requires a relatively high level of base interest rates.
Economic development
The Czech economy is gradually recovering, but it is below its potential. According to the preliminary estimate of the CZSO, GDP grew by 0.5 % quarter-on-quarter in Q4 last year, and by 1.6 % year-on-year.
Growth was driven mainly by household consumption, which was supported by renewed growth in real incomes and an easing of monetary policy restrictions. On the other hand, external demand remains subdued, stemming mainly from the decline in European industry. It is facing high energy prices, structural problems and uncertainty linked to US trade policy.
Labour market tensions are easing slightly, but unemployment remains low. Average wage growth reached 7 % in the third quarter and thus remains elevated from a historical perspective. It is also one of the reasons for the inertia in the growth of service prices.
Outlook
According to the Monetary Section's forecast, inflation would reach 2.4 % this year and fall to 2.1 % next year. Today's preliminary inflation estimate for January carries risks in the direction of slightly higher price growth this year.
According to the forecast of the Monetary Section, the Czech Republic's GDP would grow by 2 % this year, driven mainly by household consumption. By contrast, net exports will have a negative impact on the economy. According to the forecast, economic growth will accelerate to 2.4 % next year.
Risks and uncertainties
The Board assessed the risks and uncertainties to the outlook for meeting the inflation target as moderately inflationary overall. The risk to higher inflation is the higher-than-expected inertia in the growth of services and food prices. Any additional growth in total public sector spending would lead to an inflationary risk for the government budget. Increased wage demands in the private and public sectors are also an inflationary risk. Over the longer term, an acceleration of money creation in the economy stemming from a possible strong recovery in credit activity, especially in the property market, is an upside risk to inflation. Conversely, a significant downside risk to inflation is the deterioration in global economic activity and the weaker performance of the German and hence the Czech economy. Some major central banks have already responded to this risk by cutting monetary policy rates and indicating their readiness to ease monetary conditions this year. The impact of some of the steps taken by the newly elected US administration is a source of uncertainty for price developments.
Legal mandate
The Bank Board assures the public that the CNB's actions will be sufficient to maintain price stability in line with the legal mandate. At the same time, the Board is prepared to respond adequately to any risks to the inflation target outlook.
CNB/ gnews.cz - RoZ
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